Tuesday, March 16, 2010

Repo 105

I scanned a the opening few chapters on Lehman's Repo 105 and I must say, the report, while excellent in its detail, seems to be to conservative on the state of Lehman just prior to its demise. For example:

Lehman maintained approximately $700 billion of assets, and corresponding liabilities, on capital of approximately $25 billion.8 But the assets were predominantly long‐term, while the liabilities were largely short‐term.9 Lehman funded itself through the short‐term repo markets and had to borrow tens or hundreds of billions of dollars in those markets each day from counterparties to be able to open for business.10 Confidence was critical. The moment that repo counterparties were to lose confidence in Lehman and decline to roll over its daily funding, Lehman would be unable to fund itself and continue to operate.

This sets up the problem as one of liquidity, where Lehman's main problem was that other banks lost confidence in it. Certainly, this is the view of Geithner and the Obama administration. But Lehman made a huge number of loans that would not get paid back, loans they kept on their books. I don't know what the capital requirements are for whatever status of bank Lehman Bros was, but Lehman was booking income losses of $3B a quarter, and if it was honest about writing down its CRE and RE assets, it would probably blow through its remaining $22B in capital. So you have an entity with negative equity -- is its main problem that counter-parties will not lend to it?

Lehman did not turn to the Fed discount window, probably because it did not have collateral at the time, and maybe because they wanted to avoid the shame that comes with that. This to me illustrates how poorly the discount window, and interbank loan market, is designed.